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GDP: 2.5%

First, the bad news: The U.S. economy stunk the joint up in Q2, slowing sharply as inflation continued to climb.

The good news? You'll have to ask equity traders, who gapped up the market strongly this morning. They apparently see a soft landing coming. The bond market, on the other hand, aggressively bought treasuries, driving the 10 year note below a 5% handle.

Quite frankly, bond traders are more like the adult supervision of markets, while stock jockeys can be likened to hormone addled teenagers. Whenever the markets send conflicting messages, my tendency is to give more weight to the adults than the children. (And I write this as a stock trader).

As previously noted, the Q1 GDP of 5.6% was an aberration, reflecting the one off Q4 '05 growth numbers of 1.7%. By my estimates, between 30-40% of Q1 GDP was attributable to Q4 push forward caused by the hurricanes.

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Real GDP

Econoday chart courtesy of Barron's

>ec
Surprisingly this week, numerous Wall Street Economists had raised their GDP estimates, with consensus coming in at 3.2% -- despite slowing retail sales, decreased mortgage apps, and cooling home sales.

The Fed's favorite inflation indicator, the PCE a hot 4.1% (ex food and energy +2.9%).

Consumer spending still accounts for more than two-thirds of GDP, and it was up 2.5%, significantly below Q1's 4.8%.

The WSJ quoted  University of Maryland business professor Peter Morici , who said: "Higher interest rates, higher oil prices and mounting debt are burdening consumers. With the housing market cooling, consumers are no longer able to use the equity in their homes to finance ever larger purchases of clothes, electronics and other goods and services."

The Journal also noted that "Residential fixed investment, which includes spending on housing, dropped by 6.3%." This was the largest decline since 2000.

The WSJ's Fed Watcher, Greg Ip, observed "For the Fed, the revisions are, on net, a reason to be more nervous about inflation. A slower growing economy with more inflation suggests the speed at which the economy can grow without exceeding capacity limits may be lower than previously thought."

The Fed’s quandary is now greater than it was: We clearly have inflation pushing through the core rate, while the economy has WSJ's growing much more slowly. The Fed is now likely to do something very different on August 8th compared with their prior actions: They are now likely to either hold rates steady – or raise ¼ but change the statement significantly. Either way, this tightening cycle is now entering a different phase.

Maybe it finally is the 8th inning.

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Sources:
U.S. Economy Grew at 2.5% Rate In 2nd Quarter, Commerce Reports
JEFF BATER
WSJ, July 28, 2006 9:22 a.m
http://online.wsj.com/article/SB115408864917920324.html

Revision Shows Weaker Recovery
Greg Ip
WSJ, July 28, 2006 8:55 a.m.
http://online.wsj.com/article/SB115409068555020335.html

Friday, July 28, 2006 | 10:15 AM | Permalink | Comments (65) | TrackBack (1)
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Comments

So to be clear: output growth was far worse than expected, inflation far worse than expected, consumer spending slightly better than expected, business investment FELL, which, to put it charitably, is much worse than expected, and yet... equities rally cause the fed will pause. Are "investors" so myopic that they think the fed pausing will save an economy that is heading straight into a recession? Really, is the difference between 5.25 and 5.50 so important that people are missing the warning signs all around them of what's to come???

The market has been telling us for the last few weeks that we're headed into a recession - economically sensitive stocks falling, defensive sectors like pharma and food & beverage rallying, housing stocks getting crushed, etc... - and now the economic data is beginning to confirm it. My only question is whether to continue fading every rally as I have for the last 2 months or wait till the Fed does finally pause in August and fade that last gasp relief rally.

Thoughts?

Posted by: joe | Jul 28, 2006 10:35:43 AM